• 1Q17 PATMI of S$1.245bn was above our estimate by 12%.
• Surprise came from lower-than-expected provisions. But a flat y-o-y net interest income growth was in line with our expectations.
• Maintain “Reduce” rating with a higher target price of S$17.24 (previously S$16.73), pegged at unchanged 0.95x FY17F book value (excluding perpetual capital securities).

We see loans and deposits growth slowing down quarter-on-quarter (“q-o-q”). Strong loans growth was led by Housing loans (+9% y-o-y), General Commerce (+11% y-o-y) and Transport, storage & communications loans (+25% y-o-y). The Housing loans growth was driven by market share gains in the Singapore Housing loans market and the business loans growth was driven by SMEs. But in this quarter, overall loans growth has started to slow on q-o-q. Similarly, deposits grew 7% y-o-y but has stalled despite deposit rates increasing 3bps in this quarter. And we see the growth slow down coming from Hong Kong and US dollar deposits.

Net interest income (“NII”) growth was flat y-o-y and q-o-q”) as loan volume and rates continue to run in opposite ends. We observed that DBS’ Net Interest Margins remain sluggish. NIM peaked at 1.85% in 1Q16 and has been tailing off the last 3 quarters. NII is largely unchanged at S$1.8bn. We opine that the loan rate and volume dynamics for DBS is more challenging as we estimate about c.30% of its net interest income is from the competitive Corporate business segment.

Non-performing assets (“NPA”) remained stable at S$4.8bn q-o-q while coverage ratio improved from 97% to 103% q-o-q. NPA remained stable as new NPA formation decreased because the vessels used on standard offshore oil & gas operations are realising values within expected range, and supported by recoveries from some Indian non-performing loans (“NPLs”) which were sold. Uncertainty over vessel valuation lies with the lumpy specialised vessels within the offshore oil and gas space. Overall exposure to offshore oil and gas loans remain unchanged at S$5.5bn. The improvements in coverage ratio came from the divestment gains of SGD350mn from the sale of PwC building.

Strong fee and commission income supported performance. Wealth Management (“WM”), up 26% y-o-y and 41% q-o-q from higher sales of investment products and unit trusts. Management has alluded the strong performance to a strong risk-on momentum at the start of the quarter but struck a more cautious note about the sustainability of that momentum moving ahead. Nonetheless they are overall optimistic because they see strong adoption in the WM digital platforms and their study shows that client activities from digital platform double those who had not adopted the digital platform.

Investment Actions

Management’s guidance for 2017 loans and income growth continues to be mid-single digit percentage. We have revised our FY17F total income growth estimate from 5% in the previous quarter to 5.9% as we improved our FY17F NII growth estimate from 1% to 2%. We also see that the Common Equity Tier 1 Ratio is well above the threshold and so there could be room for the management to return some retained earnings to shareholders in the form of bonus dividends barring major developments to Basel 4.

But we continue to see unfavourable loan rate dynamics coming from its loans business, we are cautiously optimistic of DBS’ ability to exercise some pricing power without compromising too much volume growth. But some of the key risks still looms over the horizon – a) Owing to the low coverage ratio, we will not expect support from utilisation of General provisions to ease the unexpected spikes in provision expense arising from sudden rises in NPLs; b) Unexpected volatility in funding costs outside of Singapore base could squeeze margins. We estimate Hong Kong dollar funding at c.10% and US dollar funding at c.30% of total deposit funding.

We believe positive financial results and expectations for a bonus dividend to be fully priced in while risks are largely ignored. Therefore we maintain “Reduce” rating with a higher target price of S$17.24 (previously S$16.73), pegged at unchanged 0.95x FY17F book value (excluding perpetual capital securities).